Interim Market Commentary

Looking Ahead from a Powerful Stock Rally

Is the powerful 30% plus stock market rally that began in late March sustainable? In other words, has the market come too far too fast?

This is a trillion-dollar question. How is the S&P 500 trading only 11% below its all-time high, reached when it was contemplating strong global economic growth? Now we are in the teeth of a global recession, profits are projected to be 30-40% below last year’s reading and the coronavirus continues to disrupt business all over the globe.

It’s Almost Impossible to fight this Determined Fed

Every market event is unique, and lessons learned from past disruptions are limited. However, some useful information is gleaned by looking back at past events. The years following the 2008 financial crisis provide support for a constructive look on risk assets like stocks even at today’s levels. Today’s stock valuations make more sense when you begin to contemplate the enormous size of the monetary and fiscal stimulus applied by the Federal Reserve and Congress.

As you will recall, at the end of the Bush administration and through the first year or so of the Obama administration, a combination of heretofore unheard-of monetary easing by the Fed and fiscal stimulus from Congress ($850 million for “shovel ready jobs”) provided a support for markets. These actions were critical to the bull market that began in March of 2009 and lasted until this year.

Below is a chart (from BCA Research) which shows the level of monetary stimulus which has been applied so far during the Covid-19 pandemic. It far exceeds the measures taken by the Fed in the wake of the financial crisis. This support was delivered in record time, in a matter of weeks. Congress and the administration also delivered fiscal thrust in the form of the CARES Act and other legislation that will likely exceed $5 trillion when all is said and done. These extraordinary actions are a powerful support to markets.













Keeping the Bears Up at Night

Eventually, regardless of the amount of stimulus, the values of stocks depend on the quality and persistence of their underlying earnings. Based on today’s prices and projected 2020 earnings, the market is very expensive. Depending on which diminished estimates you use the S&P is trading around 24 to 26 times this year’s earnings. This, as we enter a potentially deep recession. Unless the market has developed a new tendency to price a more long-term perspective than we have previously seen, taking some money off the table seems like a rational decision.  So, which factor wins out? The weight of an overvalued market or the determination of public officials to support the economy and markets?

Sorting It Out

As stated in our quarterly report, we believe that between now and the end of 2020 short term rallies and declines will depend on news concerning the pandemic. There are encouraging signs on this front. In the past few weeks during the pandemic economists and strategists have been looking to non-traditional “high frequency” data to gain clues on the direction of the moribund economy. They’ve looked at things like credit card swipes, subway ridership and airline travel to see when and if the economy is turning. The accompanying charts (also from BCA) showing a noticeable upturn in the number of daily passenger flights globally. Traffic numbers and other indicators show a similar positive change in direction. In China, which is further along in recovering from the virus induced lockdown, industrial profits and capital spending is on the upswing from depressed levels. Factors such as these make it plausible to look past current dreary labor numbers and profits to focus on a better 2021 rather than a dismal 2020.



The Current U.S. Stocks Rally

The rally from the bottom has been fast and furious. It has carried us to what are, by some traditional measures, dangerously rich multiples of this year’s earnings. But importantly, this powerful rally has not been fueled by speculative fervor. Speculation is marked by things like high levels of margin debt, low levels of cash on the sidelines and bullish sentiment readings. All those factors are at the lowest levels we have seen in the better part of a decade.

Since this slowdown was caused by the quarantine, logic says that economic demand will be restored when it ends.  Current readings show a slow economic recovery beginning. Unknown is at what pace earnings and growth will resume.  We believe that the market’s current price reflects the view that 2021 profits will approach those of 2019. Based on an incipient recovery from the pandemic as shown by “high-frequency” indicators, this seems reasonable. This provides support for our current position to stay substantially invested in stocks close to target allocations. If you believe the “wall of money” created by the Fed and Congress can bridge the economy until next year then the market is properly anticipating better times ahead and today’s rich prices, make sense. However, these prices fully discount this benign outcome. As optimistic skeptics (skeptical optimists?), we will be looking for cracks in this admittedly sanguine outlook. We will not hesitate to adopt a more defensive posture if we believe it is warranted.

The Altavista Investment Team

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